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DAVID H. PATZER JEFFREY S. BILLINGS JAMES J. KROGMEIER

GODFREY & KAHN, S.C. 780 NORTH WATER STREET

MILWAUKEE, WISCONSIN 53202 (414) 273-3500

gklaw.com Dpatzer@gklaw.com Jbillings@gklaw.com

Jkrogmeier@gklaw.com

Table of Contents Page

I. FEDERAL/WISCONSIN ESTATE TAX REFORM ........................................................................1

A. Federal Reform ..............................................................................................................1 B. Wisconsin Estate Tax.....................................................................................................2 C. 2007–2008 IRS/Treasury Priority Guidance Plan—A Sampling ..................................2

II. LEGISLATIVE UPDATE...........................................................................................................2

A. Proposed Regulations on Alternate Valuation Methods (REG-112196-07) and Kohler Case....................................................................................................................2

B. Charitable Remainder Trusts and Unrelated Business Taxable Income........................4 C. Section 2053—Post-Death Events.................................................................................4

III. FAMILY LIMITED PARTNERSHIPS (“FLPS”)...........................................................................7

A. Status of IRS Attack Arguments....................................................................................7 B. IRC §2036......................................................................................................................8

IV. DEFINED VALUE .................................................................................................................13

A. Two Types of Formula Clauses ...................................................................................13 B. Choice of Valuation Approach in the Formula Clause................................................13 C. Public Policy Concerns ................................................................................................13 D. GRAT Example ...........................................................................................................14 E. Incomplete Gift Approach ...........................................................................................14

V. VALUATION ........................................................................................................................14

A. Inconsistent Valuations................................................................................................14 B. Discount for Built-in Capital Gains Tax......................................................................15 C. Multi-Level Discounts Allowed for Tiered Partnerships.............................................16 D. Rev. Ruling 2008-35: Restricted Management Accounts...........................................16

VI. DECANTING AND UNIFORM TRUST CODE IN WISCONSIN ....................................................16

A. General Requirements..................................................................................................16 B. Typical Savings Provisions..........................................................................................18 C. Gift, Income and Generation-Skipping Transfer Tax Consequences ..........................18 D. Wisconsin and the Uniform Trust Code ......................................................................19

VII. MISCELLANEOUS ................................................................................................................19

A. Tax-Exempt Bonds and Davis Case ............................................................................19 B. Revenue Ruling 2008-22: Power to Substitute Property of Equivalent Value...........19

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C. IR-2008-84: New Extension Deadlines for 2009........................................................20 D. Investment Advisory Fees............................................................................................20 E. Wisconsin Burial Form................................................................................................21 F. Section 529 Plans—Highlights of Advance Notice of Proposed Rulemaking ............23 G. Revenue Ruling 2008-41: Separating Charitable Remainder Trusts into Parts..........24 H. Qualified Disclaimer: Estate of Christiansen v. Commissioner, 130 T.C. No.

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I. FEDERAL/WISCONSIN ESTATE TAX REFORM

A. Federal Reform

1. The recent development panel at Heckerling (January 2008) (Dennis Belcher, Carol Harrington and Jeff Pennell) and Steve Akers of Bessmer Trust (July 2008) agreed that the chances for repeal of the Federal Estate Tax are slim to none and that reform will most likely occur in 2009.

a. Senators Grassley of Iowa and Baucus of Montana have agreed to hold hearings on Estate Tax repeal in 2008. The hearings are part of a deal with Senator Kyl of Arizona to persuade him to drop the Estate Tax repeal provi-sions he had proposed as an amendment to the 2007 Farm Bill. Senator Baucus (Chair of the Senate Finance Committee) promised to hold aggressive hearings in the spring of 2008. No such hearings have yet taken place.

2. Belcher felt that notwithstanding the hearings, the best prospects for reform will be in 2009.

a. A 60-vote supermajority is required in the Senate for repeal.

b. The Senate is currently comprised of 49 Democrats, 49 Republicans and two Independents, who vote mostly with the Democrats.

(i) Thirty-five Senate seats are up for election this year. Twenty-three are held by Republicans, of which five are safe, and 12 are held by Democrats, of which six are safe.

(ii) Belcher felt the Democratic majority in the Senate may increase to the mid-50 range.

3. Reform Parameters

a. Similar to last year, Belcher felt that the Applicable Exclusion Amount would be between $3,500,000 to $5,000,000 and that the Estate Tax rate would be somewhere in the range of 35% to 45%.

(i) There is a possibility of a lower rate applying to Estates up to $20,000,000, with a higher rate for any excess over that threshold, similar to the old 5% surtax.

b. Portability of exemptions between spouses was again mentioned as a possible element of the reform package.

c. Belcher also commented that there is renewed interest in re-coupling the Gift Tax and Estate Tax exemptions. No discussion has occurred regarding resur-recting the state death tax credit under former IRC §2011.

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4. Changes in Our Practice

a. Belcher commented that clients are becoming more interested in gifting strategies and more open to the possibility of paying Gift Tax to remove the Gift Tax from their Estates.

b. IRS has gotten a “second wind” and appears to be allocating more resources to enforcement and regulatory projects that impact how we service our clients (e.g., preparer penalties, Circular 230, undervaluation penalties and appraiser penalties).

B. Wisconsin Estate Tax. The Wisconsin Estate Tax expired as of January 1, 2008.

C. 2007–2008 IRS/Treasury Priority Guidance Plan—A Sampling

1. Final Regulations under §67 regarding miscellaneous itemized deductions of a Trust or Estate. Proposed Regulations were published on July 27, 2007.

2. Guidance under §642(c) concerning the ordering rules for charitable payments made by a Charitable Lead Trust.

3. Proposed Regulations under §2032(a) regarding the imposition of restrictions on Estate assets during the six-month alternate valuation period.

4. Guidance regarding consequences under various Estate, Gift and generation-skipping transfer tax provisions of using a family-owned trust company as Trustee of a Trust.

5. Guidance under §2036 regarding the tax consequences of a retained power to sub-stitute assets in a Trust.

6. Guidance under §2703 regarding the Gift and Estate Tax consequences of the transfer of assets to investment accounts that are restricted.

7. Guidance under §2704 regarding restrictions on the liquidation of an interest in a corporation or partnership.

II. LEGISLATIVE UPDATE

A. Proposed Regulations on Alternate Valuation Methods (REG-112196-07) and Kohler Case

1. History

a. Section 2001 imposes a tax on the transfer of the taxable Estate of every decedent who is a citizen or resident of the United States. Section 2031(a) provides that the value of the decedent’s Gross Estate includes the value at the time of decedent’s death of all property, real or personal, tangible or intan-

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gible, wherever situated. Section 2032(a) provides that the value of the Gross Estate instead may be determined, if the Executor so elects, by valuing all the property included in the Gross Estate (other than property distributed, sold, exchanged, or otherwise disposed of within six months after the decedent’s death) as of the date that is six months after the decedent’s death.

b. In Flanders v. United States, 346 F.Supp 95 (N.D. Cal. 1972) the District Court held that the reduction in value of property included in the decedent’s Estate as a result of a voluntary act by the Trustee, instead of as a result of market conditions, could not be taken into consideration in valuing the property under the alternate valuation method. In that case, a few months after the death of the decedent, the Trustee of the Trust owning the decedent’s undivided one-half interest in real property entered into a Land Conservation Agreement pursuant to the California Land Conservation Act of 1965. In exchange for restricting the property to agricultural uses for a period of 10 years, the Trustee was allowed to reduce the assessed value of the land for purposes of paying property taxes. The Estate elected to use the alternate valuation method for Estate Tax purposes and reported the value of the decedent’s interest in the land as $25,000. This value represented one-half of the value of the ranch after the land use restriction was placed upon it, less a lack of marketability discount. The District Court stated that, “[i]t seems clear that Congress intended that the character of the property be established for valuation purposes at the date of death. The option to select the alternate valuation date is merely to allow an Estate to pay a lesser tax if unfavorable market conditions (as distinguished from voluntary acts changing the char-acter of the property) result in a lessening of its fair market value.”

c. In Kohler v. Commissioner, T.C. Memo 2006-152, the Tax Court held that valuation discounts attributable to restrictions imposed on closely-held cor-porate stock pursuant to a post-death reorganization of Kohler Company should be taken into consideration in valuing stock on the alternate valuation date. In that case, approximately two months after the death of the decedent, Kohler Company underwent a reorganization that qualified as a tax-free reorganization under §368(a) and, thus, was not a sale or disposition for pur-poses of §2032(a)(1). The Estate opted to receive new Kohler shares that were subject to transfer restrictions. The Estate elected to use the alternate valuation method under §2032(a)(2) and took into account discounts attribut-able to the transfer restrictions on the stock in determining the value for Federal Estate Tax purposes. In Internal Revenue Bulletin No. 2008-9 on March 3, 2008, the IRS non-acquiesced to the Tax Court opinion in Kohler.

2. Proposed Regulations

a. The Proposed Regulations re-affirm the position taken in Flanders. The Pro-posed Regulations will amend §20.2032-1 by restructuring paragraph (f) of this Section to clarify that the election to use the alternate valuation method under §2032 is available to Estates that experience a reduction in the value of

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the Gross Estate following the date of the decedent’s death due to market con-ditions, but not due to other post-death events.

b. The term “market conditions” is defined as events outside of the control of the decedent (or the decedent’s Executor or Trustee) or other person whose prop-erty is being valued that affect the fair market value of the property being valued. The term “post-death events” includes, but is not limited to, a reor-ganization of an entity (for example, corporation, partnership, or limited liability company) in which the Estate holds an interest, a distribution of cash or other property to the Estate from such entity, or one or more distributions by the Estate of a fractional interest in such entity.

B. Charitable Remainder Trusts and Unrelated Business Taxable Income

1. Background. Prior to the Tax Relief and Health Care Act of 2006 (“TRHCA”), a Charitable Remainder Trust (“CRT”) with unrelated business taxable income (“UBTI”) lost its tax exemption and became fully taxable for its entire net income.

2. New Regulations

a. The new Regulations under §1.664-1 ease the tax treatment of CRTs with UBTI. Specifically, the CRT will not lose its tax exempt status, but the Trust will have to pay an excise tax equal to 100% of the UBTI.

b. UBTI is calculated under IRC §512 and allows for a $1,000 deduction.

c. The excise tax is charged to corpus and does not reduce the distribution to the non-charitable beneficiary.

d. The UBTI earned by the Trust is still counted as income in determining the character of the income distributed to the beneficiary. There is no reduction for the excise tax paid.

C. Section 2053—Post-Death Events

1. Background

a. In Ithaca Trust v. Commissioner, 279 U.S. 151 (1929), the Supreme Court held that post-death events should not be considered in the determination of the value of deductions for Estate Tax purposes. The issue in Ithaca Trust was whether the actuarial tables should be used in valuing marital and charit-able deductions when the decedent’s wife survived the decedent but died prior to the filing of the Estate Tax Return.

b. In Propstra v. United States, 680 F.2d 1248 (9th Cir. 1982), the Ninth Circuit allowed deductions in full for liens against real estate in the decedent’s Estate,

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even though the liens were settled for a substantially reduced amount two years after the Estate Tax Return was filed.

c. The Fifth, Tenth, Eleventh and Seventh Circuits follow Ithaca Trust’s “date of death” valuation rule. Estate of Smith v. Commissioner, 198 F.3d 515 (5th Cir. 1999), Estate of McMorris v. Commissioner, 243 F.3d 1254 (10th Cir. 2001), Estate of O’Neal v. United States, 258 F.3d 1265 (11th Cir. 2001), Commissioner v. Strauss, 77 F.2d 401 (7th Cir. 1935).

d. The Eighth Circuit in Jacobs v. Commissioner, 34 F.2d 233 (8th Cir. 1929), cert. denied, 280 U.S. 603 (1929), follows the approach that the amount deductible under IRC §2053 is limited to amounts actually paid by the Estate. The Eighth Circuit narrowly reads Ithaca Trust to apply only to the marital or charitable deduction.

2. The Proposed Changes Under the Regulations

a. Post-death events will be considered when determining the amount deductible under §2053 and the deductions are limited to amounts actually paid.

b. Final court decisions as to the amount and enforceability of the claim will be accepted in determining the amount of the deduction if the court ruled on the facts upon which deductibility depends.

c. Settlements are accepted if they are reached in bona fide negotiations between adverse parties with valid claims recognizable under applicable law and if the settlement is not inconsistent with the applicable law.

d. A protective claim for refund under IRC §6511 may be filed before the expiration of the statute of limitations to preserve the Estate’s right to claim a refund if the amount of the liability is not ascertainable by the expiration of the statute of limitations.

e. A deduction is not allowed to the extent the expense or claim is compensated by insurance or otherwise reimbursed.

f. No deduction may be taken for a claim that is potential, un-matured, or con-tested at the time of the filing of the return.

g. When a claim involves multiple defendants, the Estate may deduct only the decedent’s portion of the liability.

h. Claims by family members or other beneficiaries of a decedent’s Estate will be strictly scrutinized to ensure that their claims are legitimate.

i. If a claim becomes unenforceable after the decedent’s death, no deduction will be allowed.

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j. If a claim represents a decedent’s obligation to make recurring payments that extend beyond the final determination of the Estate Tax liability, a deduction is allowed only as each payment is made, provided that the statute of limita-tions has not expired or the Estate has preserved a claim for a refund.

k. Alternatively, a deduction is allowed for the cost of a commercial annuity pur-chased by the Estate from an unrelated dealer in satisfaction of an obligation to make recurring payments.

l. The Proposed Regulations establish a rebuttable presumption that all claims by a family member (spouse, grandparents and parents of decedent or spouse, siblings of decedent or spouse, lineal descendants of decedent or spouse, spouse and lineal descendants of any grandparent, parent or sibling of decedent or spouse) are not legitimate and therefore not deductible.

m. Exception to General Rule: If a claim is “ascertainable with reasonable cer-tainty and will be paid,” it may be deducted on the Estate Tax Return. How-ever, if the payment is later waived or left unpaid, the taxpayer or his or her representative must notify the Commissioner and pay the Estate Tax and interest.

n. Attorneys’ fees may be deducted in amounts actually paid or may reasonably be expected to be paid. The same rule applies for Personal Representative or Trustee fees.

3. ACTEC Comments

a. Other than the Eighth Circuit’s position, case law is clear that §2053 requires a date of death valuation approach.

b. The rebuttable presumption for claims by family members conflicts with §7491 which shifts the burden of proof to IRS when the taxpayer presents credible evidence as to a factual matter.

c. Claims and counterclaims are valued differently, rather than being offset upon resolution. Under the Proposed Regulations, a claim by an Estate against a third party is an asset of the Estate that must be valued as of the date of death, but a counterclaim by a third party against the Estate is allowed only when paid. The Estate is required to pay Estate Tax on the Estate’s claim, but will get no deduction for the counterclaim until paid.

4. Additional Problems – Richard Covey

a. The Regulations produce a flawed result if the §2053 expenses are charged to an interest that qualifies for the marital or charitable deduction, which are determined as of the date of death, or against a Credit Shelter Trust if the claim exceeds the decedent’s Applicable Exclusion Amount. In either case, a tax-free plan may generate Estate Tax.

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(i) For example, assume a $10,000,000 Estate passes entirely to a Marital Trust because the decedent had used his $2,000,000 Applicable Exclusion Amount to make gifts. An un-matured claim of $5,000,000 exists, which is appraised at $3,000,000 as of the decedent’s death. Under the Regulations, the claim cannot be deducted, but the marital deduction must be reduced by the value of the claim, resulting in a marital deduction of $4,545,000 ($7,000,000 less the interrelated Estate Tax) and $2,455,000 in Estate Tax, using a 45% rate.

(ii) A deduction will be allowed when the claim is paid, assuming the Personal Representative has remembered to file a protective claim for refund. To make the Estate whole, the refund must not only take into account the deduction, but also restore the marital deduction for the full amount that would have passed to the Marital Trust had the deduc-tion been allowed initially. If the amount paid on the claim is less than the appraised value (say, for example, $1,000,000 as opposed to $5,000,000), the pre-tax marital deduction must be increased from $7,000,000 to $9,000,000. There is no authority under §2056 for revaluing the marital deduction at the time of actual payment.

III. FAMILY LIMITED PARTNERSHIPS (“FLPS”)

A. Status of IRS Attack Arguments

1. Sham Argument—that an entity formed principally for tax reduction purposes should not be respected.

a. The Tax Court has consistently rejected this argument, holding that a validly formed entity under state law should be respected for Federal transfer tax pur-poses. See Kerr v. Commissioner, 113 T.C. 449 (1999), Estate of Strangi v. Commissioner, 115 T.C. 478 (2000).

b. Porter indicated that IRS rarely raises the sham argument anymore.

2. IRC §2703 Argument—that the partnership agreement itself is a “restriction on the right to sell or use” the underlying partnership “property,” and as a conse-quence, the agreement should be ignored for valuation purposes unless it satisfies the three-prong test of IRC §2703 (bona fide business arrangement, not a testa-mentary device, the terms are comparable to similar arrangements entered into in arm’s-length transactions).

a. The courts have uniformly rejected this argument, concluding that the word “property” in IRC §2703 refers to the interest being transferred (i.e., the part-nership interest), not the underlying partnership assets.

b. Porter indicated that IRS is still using the IRC §2703 to attack valuation dis-counts in FLPs, arguing that restrictions in the partnership agreement should be ignored for valuation purposes unless commercially reasonable. One

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example noted by Porter was a right of first refusal provision in an agreement using the applicable Federal rate for the deferred payments under a promis-sory note.

3. Gift on Formation Argument—a gift occurs upon the formation of the partnership equal to the difference between the value of the assets contributed to the partner-ship and the value of the partnership interests received in exchange.

a. The courts have rejected this argument if the partnership is a pro rata part-nership and each partner’s contributions are reflected in his or her capital account. See Jones v. Commissioner, 116 T.C. 121 (2001).

B. IRC §2036

1. The trend in recent court decisions is to concentrate on the “bona fide sale for adequate and full consideration” exception to IRC §2036, which appears to pre-dict the §2036 inclusion conclusion. If the exception is not satisfied, §2036 inclusion most likely will result.

2. To satisfy the exception, there must be a legitimate and significant non-tax reason for the creation of the partnership. Estate of Bongard v. Commissioner, 124 T.C. 95 (2005), Estate of Rosen v. Commissioner, 91 T.C. Memo 1220 (2006), Strangi v. Commissioner, 429 F.3d 1154 (5th Cir. 2005), Estate of Thompson v. Commissioner, 382 F.3d 367 (3rd Cir. 2004).

3. IRS is increasingly arguing that a legitimate and significant non-tax reason for the formation of the partnership is tantamount to a business purpose test.

a. In Rosen, Judge Laro of the Tax Court stated that there was no legitimate, significant non-tax reason for the formation of the partnership because in part there was no active business operated by the partnership. In his concurring opinion in Bongard, Judge Laro argued that the appropriate test was whether the partnership was involved in an active business enterprise. This position was not adopted in the majority opinion.

b. In Bigelow v. Commissioner, 503 F.3d 955 (9th Cir. 2007), the Ninth Circuit affirmed the Tax Court’s conclusion that Ms. Bigelow’s assets (which were transferred to the partnership by her son under a Durable Power of Attorney) were included in her Estate under IRC §2036.

(i) The Ninth Circuit rejected IRS’ Estate depletion approach to adequate and full consideration, concluding that “adequate and full considera-tion” did not require that discounts for lack of control and market-ability be ignored.

(ii) However, the Court stated that “the validity of the adequate and full consideration prong cannot be gauged independently of the non-tax

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related business purposes involved in making the bona fide transfer inquiry.”

c. The Tax Court has held that the bona fide sale exception was satisfied in two cases, Schutt v. Commissioner, T.C. Memo 2005-126 (2005) and Stone v. Commissioner, 86 T.C. Memo 551 (2003). Neither case involved a partner-ship operating an active business.

4. In Estate of Rector v. Commissioner, 94 T.C. Memo 567 (2007), Judge Laro again states that the bona fide sale inquiry requires that the transfer “be made for a legitimate and significant non-tax business purpose.”

5. Estate of Erickson v. Commissioner, T.C. Memo 2007-107, involved an FLP established by the decedent’s daughter pursuant to a Durable Power of Attorney. The decedent was in his 80s and had Alzheimer’s disease when the FLP was established.

a. Substantially all of the decedent’s assets ($2,000,000) were transferred to the FLP in exchange for an 86% limited partner interest in the FLP.

b. Several days prior to the decedent’s death, the decedent’s daughter transferred the decedent’s interest in several condominiums to the FLP and made gifts to the decedent’s grandchildren, which reduced the decedent’s interest in the FLP to a 24% limited partner interest.

c. After the decedent’s death, FLP funds were used to pay a portion of the decedent’s Estate and Gift Taxes. The funds consisted of $123,500 of sale proceeds paid to the Estate by the FLP for the purchase of the decedent’s home and $104,000 from the redemption by the FLP of a portion of the decedent’s partnership interests.

d. The Tax Court cited the following factors in support of its conclusion that the bona fide sale for adequate and full consideration exception to IRC §2036 (i.e., there was no significant non-tax purpose for the formation of the FLP) was not satisfied.

(i) The FLP consisted mainly of passive assets, the investment of which did not change after formation.

(ii) The FLP was formed unilaterally by the daughter.

(iii) The same law firm represented all partners in the FLP.

(iv) There was a delay in funding the FLP, indicating a failure to respect the partnership.

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e. Many of the foregoing factors were cited again by the Court in arriving at its conclusion that IRC §2036(a)(1) applied to cause inclusion of the FLP assets in the decedent’s Estate.

(i) Although the Court did not mention one factor as being determinative, it placed special emphasis on the fact that the partnership provided funds for payment of the decedent’s Estate Tax liability.

(ii) The Court viewed the availability of funds from the FLP to pay Estate Tax as being tantamount to personal use of partnership funds.

6. Estate of Anne Mirowski v. Commissioner, T.C. Memo 2008-74, involved an LLC created by the decedent 16 days prior to her death (which, by all accounts, was unexpected).

a. Timeline of the facts are as follows:

(i) On August 27, 2001, Ms. Mirowski created an LLC designating her-self as sole general manager.

(ii) On September 1, 2001, Ms. Mirowski transferred 51.09% of the rights under a valuable patents license agreement (that generated several million dollars per year) in exchange for 100% of the membership interests of the LLC.

(iii) From September 5, 2001 to September 7, 2001, Ms. Mirowski trans-ferred marketable securities worth approximately $62,000,000 to the LLC.

(iv) On September 7, 2001, Ms. Mirowski gifted a 16% interest in the LLC to each of her three daughters’ Trusts and retained the remaining 52%.

(v) On September 11, 2001, Ms. Mirowski died unexpectedly.

b. The decedent retained $7,500,000 of personal assets outside the LLC to pay her living expenses. After Ms. Mirowski’s death, the LLC distributed $36,400,000 to her Estate to cover Gift and Estate Taxes, legal fees and other Estate obligations. The three daughters, who after the decedent’s death owned the LLC in equal shares, did not make pro rata distributions to themselves.

c. IRS argued that the assets in the partnership should be included in the decedent’s Estate under IRC §§2036(a)(1), 2036(a)(2), 2038 and 2035(a). The Court rejected all of those arguments and found in favor of the taxpayer.

d. The Court cited the following goals of the decedent in creating the LLC to determine that the bona fide sale for full and adequate consideration exception to IRC §2036 was satisfied:

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(i) joint management of family assets;

(ii) single pool of assets to allow for investment opportunities that other-wise would be unavailable;

(iii) equal provisions for daughters;

(iv) creditor protection.

e. The court found the testimony of two of the decdent’s daughters in establishing the non-tax reasons for the establishment of the LLC to be particularly credible based on their candor, sincerity and demeanor.

f. IRS attempted to counter the bona fide test with the following arguments:

(i) Decedent did not retain sufficient assets for anticipated financial obli-gations.

(a) The Court found that the only significant financial obligation that existed when the LLC was formed and funded was the Gift Tax and there was no express or implied agreement or understanding to distribute LLC assets to pay the Gift Tax liability and that the decedent could have paid the Gift Tax by borrowing or using a portion of the expected distributions from the LLC.

(ii) Payment of Estate Taxes from LLC distributions.

(a) Court observed that at no time before September 10, 2001 did the decedent, her daughters or her physicians expect her to die.

g. IRS also argued that there was either an express or implied agreement between the decedent and her daughters that would cause the 48% interest in the LLC that the decedent gifted to be included in her Gross Estate under §2036 or §2038.

(i) IRS argued that as general partner, the decedent had the right to dis-tribute all of the income and assets of the partnership to herself and that the Court should find an express agreement between the decedent and her daughters and find inclusion under IRC §2036(a)(1). The Court responded that the general manager has a fiduciary duty under state law and that provisions of the operating agreement require pro rata allocations of profit and loss.

(ii) The Court also did not find an implied agreement between the parties even though there was a distribution to pay Estate Taxes because the death of the decedent was so unexpected.

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7. In Holman v. Commissioner, 130 T.C. No. 12, the taxpayer created an FLP with Dell stock. The Tax Court held that gifts of limited partnership units are not indirect gifts of the partnership’s underlying assets but that the restrictions in the partnership agreement on a limited partner’s right to transfer her interests should be disregarded.

a. The Court distinguished holdings in Shephard (limited partnership units were transferred before the contribution) and Senda (limited partnership units were transferred on the same day as the contributions were made) where in both cases contributions to a partnership were treated as gifts by the contributor to the other partners in proportion to their ownership percentages, citing the fact that the partnership was first formed and funded with Dell stock on November 3, 1999 and it was not until November 8, 1999 when the gifts were made. A delay of six days was sufficient to avoid the indirect gift.

b. The Court also refused to invoke the step transaction because the contribu-tions to the partnership were made six days before the transfer of the limited partnership interests. The Court stated that the taxpayers bore a real economic risk of a change in value of the partnership for the six days that separated the transfer of the stock to the partnership and the date of the gifts.

c. IRC §2703(a) provides that for purposes of the Gift Tax, the value of any property transferred by gift is determined without regard to any right or restriction related to the property. IRC §2703(b) provides that §2703(a) does not apply to disregard a restriction if the restriction satisfies the following three requirements:

(i) It is a bona fide business arrangement.

(ii) It is not a device to transfer such property to members of the decedent’s family for less than full and adequate consideration in money or money’s worth.

(iii) Its terms are comparable to similar arrangements entered into by per-sons in an arms-length transaction.

(a) The Court found that the arrangement lacked a business purpose. The partnership did little else other than holding shares of Dell stock.

(b) The Court found that transfer restrictions constitute a device because if the partnership exercised its right to purchase a non-permitted transferee’s interest at the discounted value, it would be able to repurchase the shares at less than their proportionate share of net-asset-value which would, in turn, increase the value of the remaining partners who would include natural objects of the parents’ bounty.

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(c) Even though the Court ignored the transfer restrictions in valuing the units, the Court still allowed overall discounts in the following percentages—22.41%, 22.5% and 16.5%—for the three years of gifts.

IV. DEFINED VALUE

A. Two Types of Formula Clauses

1. Adjustment clauses typically provide for a return of a portion of the gift or an increase in the sales price if the value is increased on audit. IRS does not respect value adjustment clauses for policy reasons under Commissioner v. Procter, 142 F.2d 824 (4th Cir. 1944). See also Rev. Rul. 86-41 1986-1 C.B. 300.

2. Defined value clauses define the amount of the property transferred or the pur-chase price and, therefore, unlike adjustment clauses, do not rely on a “condition subsequent” to the transfer to determine value. This is the type of clause that was given effect in Succession of McCord v. Commissioner, 461 F.3d 614 (5th Cir. 2006).

B. Choice of Valuation Approach in the Formula Clause

1. Carolyn McCaffrey has stated that she believes the best valuation approach is to use “as finally determined for Gift Tax purposes” in the formula as suggested by the Tax Court in McCord.

a. In McCord, the donees determined the value of the FLP interests by appraisal. However, this requires that at least one of the donees be an unrelated person or entity, such as a public charity.

b. McCaffrey also suggests that a Grantor Trust or Trusts be used as the donees of the formula clause gift so that there are no adverse income tax conse-quences while you wait for the value to be finally determined.

C. Public Policy Concerns

1. Commentators have suggested that a formula gift as in McCord may be subject to a Procter public policy argument. IRS waived the public policy argument on the appeal to the Fifth Circuit and relied on the Tax Court’s theory that the post-gift confirmation agreement entered into by the donees determined the value of the gift.

2. McCaffrey suggests the following formula:

“I hereby transfer to the Trustees of T Trust a fractional share of the property described on Schedule A. The numerator of the fraction is (a) $100,000 plus (b) 1% of the excess, if any, of the value of such property as finally determined for

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Federal Gift Tax purposes (the “Gift Tax Value”) over $100,000. The denomi-nator is the Gift Tax Value of the property.”

D. GRAT Example

1. Assume a client wishes to make a taxable gift of a particular asset with a pre-discount value of $2,000,000 and a discounted value of $1,000,000 to his or her children and is willing to use his or her $1,000,000 Gift Tax Applicable Exclusion Amount.

2. The client should consider transferring $1,000,000 of cash or marketable securi-ties to an Irrevocable Trust for the children and establishing a zeroed-out GRAT for the asset. The Irrevocable Trust would be a Grantor Trust, like the GRAT, and the remainder beneficiary of the GRAT. The Irrevocable Trust would lend cash to the GRAT to enable it to make the annuity payments if a shortfall arises. After the term, the asset passes to the Irrevocable Trust, which then holds the notes and its remaining assets. No income tax consequences should occur if both Trusts are Grantor Trusts.

E. Incomplete Gift Approach

1. Assume a client wishes to give his limited partnership interests to his son, which have a pre-discount value of $1,000,000 and an after-discount value of $500,000.

2. Client could transfer the interests to a Grantor Trust that immediately divides into two separate Trusts, Trust #1 and Trust #2. Trust #1 is for the son and his issue and Trust #2 is also for son and issue, but the Grantor retains a limited power of appointment over Trust #2 so the gift is incomplete.

3. The terms of the Trust would require the Trustee to allocate to Trust #1 that frac-tion of the gift of which the numerator would be $500,000 plus 1% of the excess, if any, of the value of the interest as finally determined for Federal Gift Tax pur-poses (the “Gift Tax Value”) over $500,000. The denominator would be the Gift Tax Value of the interest. Trust #2 would receive any excess of the transfer over the formula amount.

V. VALUATION

A. Inconsistent Valuations

1. PLR 200648028 involved different valuations of closely-held stock for Federal Estate Tax purposes and charitable deduction purposes.

a. The decedent owned a minority interest in a closely-held business at his death, but an Irrevocable Trust he had established also held stock in the business and was included in his Estate under IRC §2036 and/or IRC §2038. The com-bined stock holdings were treated as a single controlling position in the busi-ness and valued accordingly with no minority interest discount.

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b. In contrast to Mellinger v. Commissioner, 112 T.C. 26 (1999), which involved a QTIP Marital Trust, the decedent retained the right to affect the beneficial enjoyment of the Trust principal and retained the right to designate who would receive the remainder interest.

c. Citing Estate of Chenoweth v. Commissioner, 88 T.C. 1577 (1987), IRS ruled that the block of stock passing to charity from the decedent’s Estate must carry a minority interest discount even though the stock was valued as a controlling interest in the Estate due to the inclusion of the stock held in the Irrevocable Trust.

B. Discount for Built-in Capital Gains Tax

1. The Eleventh Circuit has reversed the Tax Court’s decision in Estate of Frazier Jelke, III, 89 T.C. Memo 1397 (2005), allowing a discount equal to the potential capital gains tax if the company were liquidated. Estate of Frazier Jelke, III, 2007 U.S. App. LEXIS 26477.

2. Jelke involved the valuation of the decedent’s 6.44% interest in a closely-held C corporation that held primarily marketable securities. The net asset value of the corporation was roughly $188,600,000 and the corporation’s investment philo-sophy was long-term growth, resulting in a low asset turnover and large unrealized gains.

3. The Estate’s expert reduced the net asset value by $51,626,884 for the built-in capital gain tax liability and then applied a 20% minority interest discount and a 35% lack of marketability discount to the after-tax value.

4. The Tax Court adopted IRS’ expert’s approach, which calculated the average turn-over of the corporation’s assets (which resulted in the assets being liquidated over 16.8 years) and divided the capital gains tax liability by that factor to arrive at an average yearly capital gains tax liability. IRS’ expert then used a 13.2% discount rate (the average annual return for large-cap stocks from 1926 to 1998) to arrive at the present value of the tax liability, $21,082,226. No appreciation in the value of the assets over the 16-year period was factored in.

5. The Eleventh Circuit felt that IRS’ approach was too speculative and required a crystal ball. The Court noted that a willing buyer would adjust the purchase price by the full amount of the tax liability because he or she could just as easily pur-chase the securities on the market without any tax exposure.

6. The Eleventh Circuit concluded that the more direct dollar-for-dollar reduction approach adopted by the Fifth Circuit in Estate of Dunn v. Commissioner, 301 F.3d 337 (5th Cir. 2002) was the more appropriate methodology due to its sim-plicity and certainty.

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C. Multi-Level Discounts Allowed for Tiered Partnerships. In Astleford v. Commissioner, T.C. Memo 2008-128, the Court allowed a lack of control and marketability discount for tiered partnership interests.

1. In 1996, Mrs. Astleford formed an FLP with her interest in an assisted living facility and simultaneously made gifts of 30% limited partnership interests to each of her three children and retained the 10% general partnership interest in the FLP.

2. In 1997, Mrs. Astleford contributed her 50% interest in a real estate general part-nership (which, among other things, held a 1,187-acre tract of farmland) and 14 other properties she owned to the partnership and simultaneously gifted additional limited partnership units to her children to bring her general partnership percent-age interest back down to 10%.

3. The Court allowed an absorption discount of approximately 20% in valuing the farmland using the taxpayer’s assumption that the farmland would sell over a four-year period because a sale of the entire tract would flood the local market for farmland. The Court reduced the 25% present value discount rate the taxpayer’s expert used in valuing the land to 10%, which was close to the return on equity that farmers actually earned in the locality.

4. The Court also allowed multi-level full discounts, citing cases that have allowed multi-level discounts where there are minority interests in both the parent and subsidiary entities and were the value of the subsidiaries (the 50% general part-nership interest was only 16% of the FLP value in Astleford) is not a significant portion of the parent entity’s assets.

D. Rev. Ruling 2008-35: Restricted Management Accounts

1. Facts. Decedent owned an interest in a restricted management account at the time of his death. The contract was for five years and contained certain transfer restrictions and provided that all of the income must be deposited into the account during the contract’s time period.

2. Holding. IRS ignored the restrictions in valuing the account and refused to allow for any discounts. It compared the arrangement to rental real estate where the owner entered into a management contract stating that the existence of a management contract would have no effect on the fair market value of the real estate.

VI. DECANTING AND UNIFORM TRUST CODE IN WISCONSIN

A. General Requirements

1. A decanting statute authorizes a Trustee to distribute the assets of an Irrevocable Trust to another Trust.

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2. Six states have adopted such statutes: New York, Delaware, Alaska, Florida, Tennessee and South Dakota.

3. Reasons to Decant

a. Extending the termination date of a Trust;

b. Adding or modifying spendthrift clauses;

c. Creating a special needs Trust;

d. Consolidating Trusts and reducing administration expenses;

e. Modifying investment/diversification powers;

f. Changing Trust situs or governing law;

g. Correcting drafting errors;

h. Altering Trustee provisions.

4. The decanting statutes typically have the following requirements:

a. The Trustee must have discretion to invade principal.

(i) New York and Florida require unfettered discretion (i.e., no ascertain-able standard).

(ii) Alaska, Delaware, Tennessee and South Dakota only require that the Trustee be authorized to invade principal, even if subject to a standard. There is no requirement that the new Trust have the same standard for principal invasion.

b. The exercise of the power cannot reduce a fixed income right.

(i) This requirement does not apply to a discretionary income interest, but is intended to apply to a beneficiary or beneficiaries who has a manda-tory income interest or an income interest for a fixed period of time, such as a QTIP Marital Trust.

(ii) Florida’s statute extends the requirement for fixed annuity or unitrust interests.

c. Beneficiaries of the new Trust

(i) New York, Delaware and Tennessee provide that the beneficiaries must be “proper objects” of the decanting power.

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(ii) Although “proper objects” is not defined in the statutes, commentators have suggested that a limited power of appointment is analogous; meaning that the original Trust beneficiaries define the class of “proper objects.” The statutes do not require that all of the benefici-aries of the old Trust be beneficiaries of the new Trust.

(iii) Florida’s statute provides that the beneficiaries of the new Trust may include only beneficiaries of the old Trust.

(iv) South Dakota’s statute allows acceleration of remainder beneficiaries in the new Trust.

(v) The New York and Delaware statutes provide the new Trust may grant a beneficiary an inter vivos or testamentary power of appointment even if not present in the old Trust, and in the case of New York, the per-mitted appointees need not be limited to the beneficiaries of the old Trust.

B. Typical Savings Provisions

1. The exercise of the decanting power may not extend any applicable perpetuities period.

2. The new Trust may not contain any provisions that would jeopardize the marital or charitable deduction.

3. Trustees with beneficial interests in the old Trust may not participate in the decanting power.

4. Spendthrift provisions do not prevent the exercise of the decanting power.

C. Gift, Income and Generation-Skipping Transfer Tax Consequences

1. If the Trustee exercising the power has no beneficiary interest in either Trust and no consent of the beneficiaries is required, no Gift or Estate Tax consequences should occur by reason of the exercise of the decanting power.

a. IRS could argue that a beneficiary’s acquiescence in the exercise is a gift if there is a shift in beneficial interest or a delay in the vesting of a beneficial interest.

2. Treasury Regulation §26.2601-1(b)(4)(i)(A) provides that the extension of a grandfathered GST Trust will not taint the exempt status if the authority under state law for the Trustee to appoint in further Trust existed at the time the Trust became irrevocable (generally, September 25, 1985 or before) and the new Trust does not violate the Federal perpetuities period.

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a. New York’s decanting statute was the first and was adopted in 1992, so the foregoing safe harbor will never apply.

b. Grandfathered GST Trusts will also be protected if the new Trust does not shift a beneficial interest to a lower generation and the time for vesting of any beneficial interest is not extended. Treas. Reg. §26.2601-1(b)(4)(i).

3. IRS has ruled that a distribution to a new Trust does not constitute a sale or exchange that would trigger gain. See PLR 200743022.

a. Caution should be exercised if the Trust property includes encumbered prop-erty or a partnership or LLC interest with a negative basis. See Crane v. Commissioner, 331 U.S. 1 (1947).

D. Wisconsin and the Uniform Trust Code. An advisory panel is currently working on the adoption of a modified version of the UTC for Wisconsin which may incor-porate a decanting provision.

VII. MISCELLANEOUS

A. Tax-Exempt Bonds and Davis Case

1. In Kentucky Department of Revenue v. Davis, U.S., No. 06-666, 5/19/08, the Supreme Court upheld Kentucky’s state law exempting interest on bonds issued by the state and its political subdivisions from income taxation while taxing interest received from other state bonds. The decision which was decided 7-2 with four concurring opinions reversed a state court decision that the law violated the Commerce Clause of the U.S. Constitution.

2. The closely-watched decision settles the tax treatment of more than $2.4 trillion in municipal bonds outstanding across the country. The opinion noted that 42 of the 43 states with income taxes have laws that are similar, if not identical, to Kentucky’s tax law.

3. Some feel that the court avoided the most problematic aspect of its decision by deciding—in a footnote—to “leave for another day any claim that differential treatment of interest on private-activity bonds should be evaluated differently from the treatment of municipal bond interest generally.”

4. The decsions ends a brief period where taxpayers could file protective disclosures in Wisconsin to keep open previous tax years for purposes of filing refunds on non-Wisconsin bonds that charged interest in the state of Wisconsin.

B. Revenue Ruling 2008-22: Power to Substitute Property of Equivalent Value

1. In Revenue Ruling 2008-22, IRS stated that a Grantor’s retained power to acquire property held in Trust by substituting other property of equivalent value will not, by itself, cause the value of the Trust corpus to be includible in his or her Gross

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Estate. Where the Grantor of an inter vivos Trust retains such a substitution power, exercisable in a non-fiduciary capacity, the Trust corpus will not be included in the Grantor’s Gross Estate under IRC §2036 or §2038, assuming a) the Trustee has a fiduciary obligation to ensure that the transfer is actually for equivalent value and b) the power cannot be exercised in a manner that can shift benefits among the Trust beneficiaries.

2. IRS noted the ruling follows the rationale of the U.S. Tax Court’s decision in Estate of Jordahl v. Commissioner, 65 T.C. 92 (1975), that a substitution power is not a power to alter, amend, or revoke a Trust. The facts presented in the Revenue Ruling, however, departed from those considered in the Court case as the Grantor in the Revenue Ruling is expressly prohibited from serving as Trustee and the Trust instrument explicitly states the substitution power is held in a non-fiduciary capacity. The Revenue Ruling also states that the Grantor “is not sub-ject to the rigorous standards attendant to a power held in a fiduciary capacity” and that “if the Trustee knows or has reason to believe that the exercise of the substitution power does not satisfy the terms of the Trust instrument because the assets being substituted have a lesser value than the Trust assets being replaced, the Trustee has a fiduciary duty to prevent the exercise of the power.”

C. IR-2008-84: New Extension Deadlines for 2009

1. Currently, the extended due date for the filing of various tax returns for both busi-nesses and individuals often falls on the same date, October 15.

2. For tax returns due on or after January 1, 2009, the following returns will be required to be filed by September 15 as opposed to October 15:

a. Form 1065—U.S. Return of Partnership Income

b. Form 1041—U.S. Income Tax Return for Estates and Trusts

c. Form 8804—Annual Return for Partnership Withholding Tax (1446)

3. The regulation does not change the process for requesting an extension of time, nor does it affect extensions of time to file other types of business returns. The purpose of the change is to provide individual taxpayers with information from flow-through entities needed to file individual returns in a more timely manner.

D. Investment Advisory Fees

1. IRC §67(e)

a. In an unanimous opinion, the Supreme Court in Knight v. Commissioner, 552 U.S. (2008), affirmed the Tax Court’s holding in William L. Rudkin Testamentary Trust v. Commissioner, 124 T.C. 304 (2005), that investment advisory fees are deductible under IRC §67(e) by a Trust only to the extent

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such fees exceed 2% of the Trust’s Adjusted Gross Income. Rudkin involved a tax deficiency of only $4,448.

b. While the Supreme Court was considering the Knight case, IRS issued Pro-posed Regulations under IRC §67(e), which presumably will be made final now that Knight has been decided, with modifications to reflect Knight.

(i) The Proposed Regulations adopt the “unique” test followed in the Second Circuit decision in Rudkin, 467 F.3d 149 (2nd Cir. 2006), that expenses are subject to the 2% haircut unless they are expenses that individuals are incapable of incurring.

(ii) In Knight, the Supreme Court followed the less strict standard adopted by the Federal Circuit in Mellon Bank, N.A. v. U.S., 265 F.3d 1275 (Fed. Cir. 2001) and the Fourth Circuit in Scott v. U.S., 328 F.3d 132 (4th Cir. 2003), that costs escaping the 2% haircut are those that would not “commonly” or “customarily” be incurred by individuals.

c. The Proposed Regulations contain a non-exclusive list of services “unique” to Trusts: fiduciary accountings, judicial or quasi-judicial filings, fiduciary income tax and Estate Tax Returns, the division or distribution of income or corpus to beneficiaries, and communications with beneficiaries regarding Trust or Estate matters. The “not unique” list includes: services rendered in the custody and management of property, investment advisory fees, advice on investing for total return, Gift Tax Returns, defense of claims, the purchase, sale, maintenance, repair, insurance or management of non-trade or business property.

d. The Proposed Regulations require that bundled fees be unbundled using a reasonable methodology. Although the Proposed Regulations do not specif-ically address Trustee fees, the government’s brief in Knight states that Trustee fees are subject to the general unbundling requirement. There is no guidance on what would constitute a reasonable allocation to investment expenses.

e. The Regulations are not limited to investment fees, Personal Representative or Trustee fees. They apply to other Estate and Trust charges, such as account-ing and legal services. As a result, the Proposed Regulations under §67(e) will disproportionately impact Estates and Trusts that take the administration expenses against income because there is no Estate Tax liability. If the expenses are taken on the Federal Estate Tax Return, IRC §67(e) is irrelevant.

E. Wisconsin Burial Form

1. Wisconsin Statute 154.30

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a. Allows competent adults to designate a representative to make final disposi-tion for declarant’s bodily remains (e.g., funeral, cremation, burial or other disposition).

b. Declarant may make special suggestions, suggest religious observances and source of funding.

c. Declarant may designate successor representatives.

2. Execution Requirements

a. Declarant is a competent adult.

b. Signed and dated in the presence of two competent adult witnesses or a notary public.

c. Witnesses may not be the representative, successor representative, or related to the declarant by blood, marriage or adoption.

d. Representative may not be a funeral director, crematory authority, cemetery authority, an employee of a funeral director, crematory authority or cemetery authority, a health care provider, or a social worker if providing professional services to the declarant or has a direct professional relationship with the declarant unless related to the declarant by blood, marriage or adoption.

e. Must provide addresses for representative and successor representatives.

f. Each representative and successor representative must also sign.

g. If declarant is unable to sign, another individual may sign in the declarant’s name at the declarant’s express direction and in the declarant’s presence.

3. Methods of Revocation

a. Execute a new declaration.

b. Signing and dating a statement declaring the document to be cancelled, revoked or void.

c. Destroying or defacing the document.

d. Writing “I hereby revoke this declaration of final disposition” on the docu-ment and signing and dating that statement.

4. Other

a. Probate court of decedent’s last residence has jurisdiction over any disputes.

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b. Funeral directors, crematory authorities and cemetery authorities may rely on the declaration.

F. Section 529 Plans—Highlights of Advance Notice of Proposed Rulemaking. Current guidance for Section 529 plans exists from 1998 Proposed Regulations. Notice 2001-55, Notice 2001-81, and the instructions and publications relating to Form 1099-Q. These will all be incorporated in a new re-proposed Regulation. The Advance Notice suggests that the new Proposed Regulation will include the following changes (about which the IRS is seeking comments).

1. Anti-Abuse Rule. A specific anti-abuse rule is proposed. One example of abuse refers to creating multiple Section 529 Plans to take advantage of multiple annual exclusions, with the intention of subsequently changing all of the plans to a single beneficiary. Another example is naming one person (e.g., a donor’s child) as the account owner of multiple plans (e.g., a separate plan for each of the donor’s grandchildren), with the intention that multiple annual exclusions shield the trans-fers from Gift Tax, but the single owner can withdraw the funds at any time.

2. Change of Beneficiary. The Advance Notice proposes to treat a change of benefi-ciary as a gift by the account owner, not the old beneficiary as under the existing rules, by treating the change “as a deemed distribution to the [account owner] followed by a new gift.” The Notice does not specify whether that deemed dis-tribution will be subject to income tax (that would appear to be prohibited by §529(c)(3)(C)(ii)). Other aspects of GST and gift taxation are also left unre-solved.

3. Distributions to Account Owners. The proposed rules would tax distributions to the account owner on the entire amount distributed less that owner’s contributions to the Plan. In effect, this means that if the account owner is a successor account owner, the entire amount distributed to the account owner (rather than just the earnings) is subject to income tax.

4. Account Owners Limited to Individuals? The Advance Notice asks for comments as to whether account owners should be limited to individuals (and UGMA or UTMA accounts). This would eliminate helpful planning now available using Trusts as owners (or at least successor account owners).

5. UTMA Accounts. UTMAs (or UGMAs) can contribute to Section 529 Plans and the contribution is not treated as a gift.

6. Account for Account Owner’s Benefit. If an individual creates a Section 529 Plan account naming himself or herself as beneficiary, the contribution is not a gift. However, transfer taxes would be imposed if the beneficiary is changed.

7. Inclusion in Beneficiary’s Estate. Five rules are proposed to provide circum-stances as to when the account will be included in the beneficiary’s Estate if the beneficiary dies before the account has been completely distributed or changed to name a new beneficiary. Rule (1): Estate inclusion results if the account is dis-

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tributed to the beneficiary’s Estate within six months of death. Rules (2) and (3): No Estate inclusion if a successor beneficiary is named who is in the same or older generation than the deceased beneficiary. (There is no indication of what happens if a new beneficiary is named who is in a lower generation than the deceased beneficiary.) Rule (4): No inclusion if the account owner withdraws the funds from the account. Rule (5): No inclusion in the beneficiary’s Estate if the account owner allows funds to remain in the account without naming a new bene-ficiary by the due date for filing the deceased beneficiary’s Estate Tax Return; the account will be deemed distributed to the account owner (making the account owner liable for income tax).

8. Five-Year Upfront Annual Exclusion Election. Rule (1): The five-year election may be made on the last Gift Tax Return filed by the donor before the due date, or if a timely return is not filed, on the first Gift Tax Return filed by the donor after the due date. The election is irrevocable. Rule (2): If the contribution in a year exceeds five years’ worth of annual exclusions, the excess is treated as a gift in the year of contribution (not spread evenly over the five-year period). Rule (3): The election may be made by the donor and the donor’s spouse by making the split gift election under §2513.

9. Timing of Distributions and Expenses. A rule will prevent making distributions too early (i.e., holding distributed funds for long periods of time with the intention of eventually using the funds for education expenses) or too late (i.e., leaving the funds in the account to grow tax deferred for a long period before seeking reim-bursement of prior education expenses) to still qualify as a non-taxable distribu-tion. The distribution must be used to pay qualified higher education expenses either earlier or later in the same calendar year or by March 31 of the following year. For example, reimbursement of expenses incurred in the prior calendar yeareven if they were just incurred days earlierwould not qualify.

10. Prospective Exceptions to Anti-Abuse Rule. When the new Regulations are issued, they will be prospective, except as to new anti-abuse rules that will be promulgated.

G. Revenue Ruling 2008-41: Separating Charitable Remainder Trusts into Parts

1. Situation 1

a. Scenario 1 involved a Trust that qualified as a CRAT or CRUT. Under the trust terms, two or more individuals would be entitled to an equal share of the annuity or unitrust amount, payable annually, during the recipient’s lifetime, and upon the death of one recipient, each surviving recipient would be entitled for life to an equal share of the deceased recipient’s annuity or unitrust amount. Thus, the last surviving recipient would be entitled to the entire annuity or unitrust amount for his or her life. Upon the death of the last sur-viving recipient, the assets of the trust would be distributed to one or more charitable organizations described in Section 170(c).

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2. Situation 2

a. Under Scenario 2, the Trust would have only two recipients who are U.S. citizens married to each other but in the process of obtaining a divorce, and, each separate Trust would have governing provisions providing that, upon the death of the recipient, that recipient’s separate Trust terminates and the assets of that separate Trust are distributed to charity. Because the remainder benefi-ciaries would receive a distribution of one-half of the assets of the Trust upon the death of the first spouse to die, under the scenario, and the remaining half of the assets upon the death of the surviving spouse, the value of the remainder payable to the remainder beneficiaries as a result of the split may be larger than the present value of that interest as computed at the creation of the Trust. Each spouse would be entitled to receive from his or her separate Trust the same share of the annuity or unitrust amount as the recipient was entitled to receive under the terms of the Trust, but each spouse would relin-quish all interests to which he or she would have been entitled by reason of having survived the other (survivorship right).

3. Guidance: In Situation 1 and Situation 2, the pro rata division of a qualified Trust into two or more separate Trusts: (1) does not cause the Trust or any of the sep-arate Trusts to fail to qualify as a CRT under §664(d); (2) the division is not a sale, exchange, or other disposition producing gain or loss; (3) the basis under §1015 and each separate Trust’s holding period under §1223 are retained; and (4) does not terminate the Trust’s status as a Trust described in, and subject to, the private foundation provisions of §4947(a)(2), and does not result in the imposition of an excise tax under §507(c).

H. Qualified Disclaimer: Estate of Christiansen v. Commissioner, 130 T.C. No. 1.

1. Background. Decedent’s Will left everything to her daughter. The Will antici-pated that her daughter would disclaim a portion of her inheritance and provided that any disclaimed property would go in part to a charitable trust (20-year term and 7% annuity payout) and in part to a charitable foundation. On audit, the Estate value increased significantly and raised two issues:

a. Can the Estate claim a charitable deduction for the present value of the 7% annuity?

b. Can the Estate claim an increased charitable deduction for the increased value of the disclaimed property passing directly to the foundation?

2. Disclaimer to Trust. IRS argued that the daughter’s retention of her contingent remainder interest in the Trust’s property made the disclaimer non-qualified under Treas. Reg. 25.2518-2(e)(3). The Court held that the disclaimed property failed to meet the requirement that the property not pass to the person making the dis-claimer. The Court reasoned that the daughter retained her contingent remainder

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interest which was neither severable property nor an undivided portion of prop-erty.

a. Savings clause was also ruled ineffective. Either failed the nine-month requirement (if read as promising to disclaim once the case is decided) or failed to identify the disclaimed property (if read as having been made when the disclaimer was originally signed).

3. Disclaimer in Favor of Foundation. IRS argued that the increased amount passing to charity did not qualify for the charitable deduction because a) any increase was contingent on a condition subsequent or b) the disclaimer’s adjustment phrase—that the fair market value of the disclaimed property will be such value as is finally determined for Federal Estate Tax purposes—is void as contrary to public policy.

a. IRS cited Treas. Reg. §20.2055-2(b)(1) which disallows a charitable deduc-tion if as of the date of death, a transfer for charitable purposes is dependent on the performance of some act or the happening of a precedent event in order that it might become effective. The Court concluded that the regulation does not apply because the regulation refers to a transfer, but the transfer in this case occurred as of the date of the disclaimer (which relates back to date of death) and not as of the date the value was finally determined.

b. The Court could not find public policy grounds to disallow the disclaimer and distinguished Procter (which voided a tax clause on public policy grounds because the provision would discourage the collection of taxes; would render the Court’s own decision moot; and would upset final judgments) saying that the increase in value of the disclaimed property would not undo a transfer, but would reallocate the value of the property between the daughter, the Trust and the foundation. The court further stated that IRS audits are not the only protection against low values citing the fiduciary obligations of executors and trustees as well as the duty of the directors of charitable organizations and the state attorney generals to protect charities from low valuations.

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